Focus Areas:    Antitrust

Section 2 Symposium: Thom Lambert on The DOJ-FTC Divide on Bundled Discounts

lambertThom Lambert is an Associate Professor of Law at University of Missouri Law School and a blogger at Truth on the Market.

A bundled discount occurs when a seller offers to sell a collection of different goods for a lower price than the aggregate price for which it would sell the constituent products individually. Such discounts pose different competitive risks than single-product discounts because, as I explained in this post, they may have an exclusionary effect even if they result in a price that exceeds the cost of producing the bundle. In particular, even an “above-cost” bundled discount may have the effect of excluding rivals that (1) are more efficient at producing the products that compete with the discounter’s but (2) produce a less extensive product line than the discounter. In other words, bundled discounts may drive equally efficient but less diversified rivals from the market.

Given that they are a “mixed bag” practice (some immediate benefits, some potential anticompetitive harms) and pose risks beyond those presented by straightforward predatory pricing, courts and commentators have struggled to articulate a legal standard that would prevent unreasonably exclusionary bundled discounts without chilling procompetitive bundling. With the notable exception of the en banc Third Circuit’s LePage’s decision, which is essentially standardless, most of the approaches courts and commentators have articulated for evaluating bundled discounts have involved some sort of test that compares prices and costs. Chapter 6 of the Department of Justice’s Section 2 Report explains the various “price-cost” tests in detail.

Based on the presentations in the Section 2 hearings, the Department reached essentially four conclusions concerning bundled discounts:

FIRST, it concluded that when a defendant’s bundle is replicable (because rivals either sell the same collection of products or could coordinate with other sellers to offer such a bundle), the defendant’s bundled discount should be legal as long as the discounted bundle price is above the defendant’s aggregate cost of producing the products in the bundle. (This is a straightforward application of Brooke Group.)

SECOND, the Department concluded that if a competitive bundle is not available, a bundled discount should be legal if, after attributing the entire amount of the bundled discount to the “competitive” product (i.e., the product sold by rivals purportedly excluded by the discount), that product is priced above the discounter’s cost. (This is the so called “discount attribution” approach the Ninth Circuit endorsed in PeaceHealth.)

THIRD, the Department concluded that a bundled discount that does not fall within one of these safe harbors should not be automatically condemned. Instead, the plaintiff should be required to “demonstrate actual or probable harm to competition.” If the plaintiff cannot show that rivals exited the market in response to the discount or that such exit is reasonably imminent, then “courts should be especially demanding as to the showing of harm to competition.”

FOURTH, consistent with the general disproportionality test it adopted in an effort to incorporate decision theory, the Department concluded that a bundled discount falling outside the aforementioned safe harbors “should be illegal only when (1) it has no procompetitive benefits, or (2) if there are procompetitive benefits, the discount produces harms substantially disproportionate to those benefits.”

On the whole, these are eminently sensible conclusions. The first (“follow Brooke Group if the bundle is replicable”) correctly recognizes that the possibility of bundle-to-bundle competition makes an instance of bundled discounting analogous to straightforward predatory pricing, so the same liability rule should govern. The second (endorsing the PeaceHealth rule) is based on the sensible notion that any equally efficient single-product rival could meet a discount that passed muster under the “discount attribution” test. The third recognizes that bundled discounting, which is ubiquitous in competitive markets, is not an inherently suspect practice, so the normal proof burdens should apply. (The observation that courts should be especially reticent to impose liability when the plaintiff cannot establish actual or likely exit of rivals acknowledges that rivals persisting in the market would likely expand output in response to the defendant’s supracompetitive pricing and would thereby prevent any harm to competition.) Finally, the fourth conclusion recognizes that bundled discounts provide a procompetitive bird in the hand — immediate lower prices — that should not be sacrificed unless the anticompetitive bird in the bush is pretty sizeable.

In contrast to the Department’s sensible conclusions on bundled discounts, the dissenting FTC Commissioners’ criticisms are unpersuasive. First, the Commissioners complained that “no Supreme Court decision has ever blessed the use of any price-cost rules of legality for any practice except predatory pricing.” That observation is both inapposite and untrue. It’s inapposite because the whole point of the agencies’ investigation of bundled discounts was to craft workable principles in an area in which the lower courts have split and the Supreme Court has not yet ruled; it’s hardly fair to criticize a rule for lack of precedential support when the slate is blank. The observation is untrue because the Supreme Court has endorsed the use of price-cost tests outside the context of predatory pricing — namely, in the area of predatory bidding (see Weyerhaeuser). Despite the fact that predatory bidding is unlike predatory pricing (and bundled discounting, for that matter) in that it does not necessarily provide an immediate benefit to consumers, the Supreme Court did endorse a price-cost test for determining liability. There is no reason to suppose the Court would not approve some sort of price-cost test in evaluating bundled discounts.

The dissenting Commissioners’ second complaint about the Department’s bundled discounts analysis was that it “does not mention the possibility of analyzing bundled discounts as a form of exclusive dealing instead of affording them the protection of price-cost ‘safe harbors’ and requiring proof of ‘disproportionality’….” Presumably, the dissenting Commissioners reasoned that bundled discounting, by usurping business from the discounter’s rivals, may have foreclosure effects similar to those occasioned by exclusive dealing.

If that’s the dissenters’ reasoning, the Department’s decision to focus on price-cost safe harbors was entirely appropriate. Absent an express covenant of exclusivity between a bundled discounter and its customers, any “exclusive dealing” stemming from a bundled discount would result from the fact that buyers voluntarily chose to patronize the discounter over its competitors because the discounter’s products were cheaper. And if either of the safe harbors endorsed by the Department applied, then any aggressive and equally efficient rival could match the discounter’s price cut and thereby neutralize the discount’s “foreclosure” effects. Thus, a rival who suffered exclusive dealing-like foreclosure effects from the defendant’s bundled discount would do so because it was either relatively inefficient (unable to meet the defendant’s discount) or unwilling to engage in vigorous price competition. The safe harbors, then, will eliminate any “de facto exclusive dealing” claims in which the plaintiff’s “foreclosure” was deserved. The safe harbors are logically prior to any analysis of anticompetitive foreclosure because if they exist, any foreclosure cannot have been anticompetitive. (More on this here.)

While the Department’s bundled discounts analysis seems sound and suffers no damage from the dissenting Commissioners’ silly criticisms, I would have preferred a bit more detail on the showing required of plaintiffs in cases that are not subject to one of the safe harbors. In particular, the Department should have required that the plaintiff establish two additional facts that seem to be pre-requisites to significant anticompetitive harm. First, the plaintiff should be required to prove that the market for the competitive product is susceptible to sustained supracompetitive pricing. If entry barriers are low so that supracompetitive pricing would be impossible, then the bundled discounter could not exercise market power after rivals exited the market, and precluding the bundled discount would merely cause consumers to forego an immediate price cut that could not enable higher future prices. Second, the plaintiff should be required to show that the bundled discount was offered to a substantial percentage of potential buyers of the competitive product and therefore threatened significant foreclosure effects for rival sellers. Many bundled discounts are negotiated by powerful buyers, are not offered generally, and could not foreclose the discounter’s rivals from the market even if effective at winning business from those rivals. (More on that here.) To ensure that bundled discounts are condemned only upon a showing of harm to competition, rather than harm to an individual competitor, a plaintiff should be required to show that the challenged bundled discounting scheme threatened significant foreclosure effects.

In sum, the Department’s conclusions concerning legal standards for evaluating bundled discounts seem fundamentally sound. While I would have preferred that the Department endorse a rule requiring plaintiffs to show that the competitive market is susceptible to supracompetitive pricing and that the discounting scheme is pervasive enough to create significant foreclosure, the suggested safe harbors and proof requirements seem appropriate. The dissenting FTC Commissioners’ criticisms are simply off-base.

Posted in antitrust, law and economics, section 2 symposium, truth on the market